A surreal image of a crypto liquidity pool being drained by arbitrage losses.

Are You Losing Money Providing Liquidity to Crypto AMMs? New Research Reveals the Hidden Costs

Elliot Brynn in Tech & Innovation December 2025 • 4 min read.

"A comprehensive study uncovers that liquidity providers on Automated Market Makers (AMMs) may be losing more than they earn due to arbitrage losses, challenging the sustainability of DeFi's core infrastructure."

Automated Market Makers (AMMs) have revolutionized decentralized finance (DeFi), becoming essential for trading and liquidity. These platforms hold billions in liquidity, facilitating trillions in trading volume. But there's a nagging question: are liquidity providers (LPs) adequately compensated for the risks they take?

While LPs earn fees from trades, they also face 'adverse selection costs.' One significant cost is the loss to arbitrageurs. AMMs, particularly Constant Function Market Makers (CFMMs), can be vulnerable to arbitrage because their prices may lag behind those on centralized exchanges. Arbitrageurs exploit these price differences, profiting at the expense of LPs.

A groundbreaking study formalized these losses, terming them 'loss-versus-rebalancing' (LVR). This metric compares the value of an LP's position in an AMM to a rebalancing portfolio that executes the same trades at external market prices. If fees don't cover these losses, providing liquidity becomes unprofitable. This article explores the profitability of liquidity provision, revealing that in many cases, LPs are losing money.

The Shocking Truth: Arbitrage Losses Exceed Trading Fees

A surreal image of a crypto liquidity pool being drained by arbitrage losses.

The recent research empirically studied the profitability of liquidity provision by comparing historical earnings from trading fees to arbitrage losses across top Uniswap V2 and V3 pools. The study simulated arbitrage losses by assuming the AMM pools were consistently rebalanced to Binance prices, representing the most liquid centralized exchange.

The findings were startling: fees often fail to compensate for arbitrage losses in many of the largest Uniswap liquidity pools. This means that LPs are effectively subsidizing arbitrageurs, calling into question the economic incentives for providing liquidity to these pools.

Uniswap V3 Dominance Doesn't Guarantee Profit: Despite being the market leader, many of the most-traded Uniswap V3 pools are unprofitable for LPs due to high arbitrage losses.
Uniswap V2: A Surprisingly Solid Choice: The older Uniswap V2 pools often prove more profitable for passive LPs than their V3 counterparts, suggesting that concentrated liquidity may not always be the best strategy.
Not All Pools Are Created Equal: Some pools with less-traded tokens can still be profitable, indicating that the relationship between fees and arbitrage losses varies significantly depending on the specific trading pair.

These results highlight the importance of carefully evaluating the potential for arbitrage losses before providing liquidity to an AMM. Factors such as the trading pair, the AMM version, and the overall market conditions can all impact profitability.

What Can Be Done? Exploring Solutions to Mitigate Arbitrage Losses

The research also investigated how arbitrage losses change with block times, finding that faster block production reduces losses. However, the rate of decline varies across trading pairs, suggesting potential benefits to innovative AMM designs.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2404.05803,

Title: Measuring Arbitrage Losses And Profitability Of Amm Liquidity

Subject: cs.dc q-fin.tr

Authors: Robin Fritsch, Andrea Canidio

Published: 08-04-2024

Everything You Need To Know

Are liquidity providers on crypto Automated Market Makers actually losing money, and why is this happening?

Recent research indicates that liquidity providers on crypto Automated Market Makers (AMMs) may indeed be losing money. This is primarily due to 'adverse selection costs,' specifically losses to arbitrageurs. Constant Function Market Makers (CFMMs) within these AMMs often have prices that lag behind centralized exchanges. Arbitrageurs exploit these price differences, profiting at the expense of liquidity providers whose trading fees may not cover these arbitrage-related losses. This situation challenges the sustainability of DeFi's core infrastructure, as liquidity providers are essential to the functionality of AMMs.

What is 'loss-versus-rebalancing' (LVR), and how does it relate to the profitability of providing liquidity to AMMs?

'Loss-versus-rebalancing' (LVR) is a metric used to formalize and measure the losses incurred by liquidity providers in Automated Market Makers (AMMs). It compares the value of a liquidity provider's position in an AMM to a rebalancing portfolio that executes the same trades at external market prices. This comparison reveals the cost of providing liquidity, taking into account arbitrage losses. If the trading fees earned by liquidity providers do not exceed the LVR, providing liquidity becomes unprofitable. LVR is crucial for evaluating the true profitability of participating in AMMs.

The study mentioned Uniswap V2 and V3 pools. How do their profitability compare for liquidity providers, considering arbitrage losses?

The study comparing Uniswap V2 and V3 pools revealed surprising differences in profitability for liquidity providers. Despite Uniswap V3's dominance in the market, many of its most-traded pools are unprofitable for liquidity providers due to high arbitrage losses. Surprisingly, the older Uniswap V2 pools often prove more profitable for passive liquidity providers than their V3 counterparts. This suggests that the concentrated liquidity model of V3 may not always be the best strategy for profitability, as it can increase vulnerability to arbitrage.

What factors should liquidity providers consider to mitigate arbitrage losses when providing liquidity to an AMM?

To mitigate arbitrage losses when providing liquidity to an Automated Market Maker (AMM), liquidity providers should carefully evaluate several factors. These include the specific trading pair, the AMM version (e.g., Uniswap V2 or V3), and the overall market conditions. Some pools with less-traded tokens can still be profitable, indicating that the relationship between fees and arbitrage losses varies significantly depending on the trading pair. Understanding these factors and their potential impact on profitability is essential for making informed decisions about providing liquidity.

How does block time affect arbitrage losses in Automated Market Makers (AMMs), and what does this imply for AMM design?

Research indicates that faster block production reduces arbitrage losses in Automated Market Makers (AMMs). This is because quicker block times allow AMM prices to update more rapidly, reducing the time window for arbitrageurs to exploit price discrepancies. However, the rate of decline in arbitrage losses varies across trading pairs, suggesting that innovative AMM designs could potentially further minimize these losses. This finding implies that improvements in blockchain technology and AMM design could enhance the profitability and sustainability of providing liquidity to decentralized exchanges.